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socrateaser, Lawyer

Category: Tax

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I have inherited a personal C corp from my mother as stock.

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I have inherited a personal C corp from my mother as stock. I own 95% stock, my sister owns 5%. Its a personal service corp (engineering) which incidentally I have run for 20 years and still run. Assets are about $1,000,000, about half cash and half accounts receivable and loans to a separate C corp of which I own 100%. Am I right to understand, that I can:

1. Liquidate the inherited corp, pay any capital gains tax, and keep the net cash tax-free? (5% to my sister).or,2. Keep running the inherited corp, but I couldn't get any cash out tax-free? What would be the proper accounting entries in equity accounts in this case, i.e. Ret. Earnings, Common Stock? Would I create a new equity account such as Proprietary Capital? If I took dividends they would be subject to personal income tax, correct?

3. What other options do I have to get tax-free cash from the inheritance? For example, could I sell some of my stock back to company? Could I sell it to family members?

A: A C Corporation is a separate legal entity. The corporation can liquidate its assets, and then you could distribute the cash after paying all liabilities. Your capital gain (reported on Form 1040, Schedule D) would be your basis (i.e., the value of the shares on the date of death of the former owner) subtracted from the net cash in the corporation at dissolution. You would receive 95% of that cash and your sister 5%. There would be no other federal or state taxes. 2. Keep running the inherited corp, but I couldn't get any cash out tax-free? What would be the proper accounting entries in equity accounts in this case, i.e. Ret. Earnings, Common Stock? Would I create a new equity account such as Proprietary Capital?

A: There are no new accounting entries. You have inherited the stock, not the corporation. The corporation is a separate legal entity, and its accounting remains the same regardless of who owns the shares.

A: Dividends are subject to taxation as ordinary income and reported on Form 1040, Schedule B. 3. What other options do I have to get tax-free cash from the inheritance?

A: You could borrow money from the corporation and then pay it back over time. Even in your #1 scenario, above, you would be paying capital gains on the stock. It just happens that your basis is stepped up to fair market value due to the death of the former owner, so your capital gain is minimal (or, perhaps zero). For example, could I sell some of my stock back to company?

A: Yes, but that would still be subject to capital gains. Could I sell it to family members?

A: Yes, but that would still be subject to capital gains.

If the goal is to get all the cash, then either selling the assets and dissolving the corporation, or simply selling the stock to the highest bidder is probably the best solution. But, you are giving up any future increase in value or potential dividend or other income. As the majority owner, you can pay yourself a salary or a stipend as a director. That money is taxable, but having an income stream may be better in the long run than dissolving the corp or selling your ownership interest.

Because of the onerous regulatory requirements connected with the sale of stock in the open market, there is no inexpensive means of valuing the stock. You can have a CPA with business appraisal experience value the business. Unfortunately, it won't be cheap.

Here's an example of a business that does this sort of appraisal. Note: I do not recommend nor disparage any business in this forum. The link is simply an example of a California business offering the services you require.

It's the same answer. You need a valuation that removes the possibility of the IRS claiming that you have committed a "substantial undervaluation." Otherwise, you could be subject to huge penalties. Given that you contemplate a sale to family members, the IRS will not presume that an arm's length transaction has occurred, so you are likely to be audited. The only way to protect yourself is with a quality appraisal from a CPA who can testify, if necessary, to the method of valuing the business.

Excellent information, very quick reply. The experts really take the time to address your questions, it is well worth the fee, for the peace of mind they can provide you with. OrvilleHesperia, California

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